Home Depot Unit Sees Price Plunge in a Tight Market

Monday

Aug 27, 2007 at 5:35 AM

The company dropped the sale price of its commercial supply business by nearly $2 billion, one of the first big buyouts renegotiated amid the credit squeeze.

Home Depot was forced to drop the sale price of its commercial supply business by nearly $2 billion yesterday, according to people involved in the negotiations, one of the first big buyouts to be renegotiated as a result of the recent tightening of credit and problems in the housing market.

The refashioned deal cut the sale price roughly 18 percent, to $8.5 billion. Because the deal relies heavily on debt, investors and bankers have been watching it closely for signs of how new limits on credit could affect other large buyouts that are still pending and are worth nearly $400 billion collectively.

Still, this deal is different in that the fortunes of Home Depot Supply, as the division is called, are tied closely to the housing market, which has also been weakening.

After a series of all-night negotiations to save the deal, Home Depot and the participating banks and buyout firms were all forced to put up more money to shore up the financing. The parties involved in other pending deals could find themselves in a similar position as buyout firms drag sellers back to the negotiating table. That could put a damper on the buyout boom that has been a major factor in the runup in stock prices over the last few years.

Home Depot’s board approved the deal in principle during a meeting yesterday afternoon, people involved in the negotiations said, and the company plans to announce the transaction today.

The Home Depot deal involves some of Wall Street’s biggest players. The buying consortium includes the Carlyle Group, Bain Capital and Clayton Dubilier & Rice, and the banks financing the deal include Lehman Brothers, JPMorgan Chase and Merrill Lynch.

The reworked transaction raised the curtain on the complicated relationships between investment banks and some of their biggest clients: the private equity firms who shower them with billions of dollars in fees annually. In the Home Depot negotiations, however, those normally friendly relationships quickly turned cold, as all the players eventually demanded heavy concessions from one another.

By the time Home Depot’s board reached its agreement, some of Wall Street’s most powerful executives had stepped in to personally negotiate the deal:

James Dimon, chief executive of JPMorgan Chase, pulled several all-nighters, ordering in pizza with his colleague, James B. Lee, a vice chairman; Richard S. Fuld Jr., the chief executive of Lehman Brothers, was sending e-mail messages from his BlackBerry at 5 a.m.; and E. Stanley O’Neal, chief executive of Merrill Lynch, was taking calls on the golf course, against the club’s rules.

Kenneth D. Langone, a prominent Home Depot board member and a fixture on Wall Street, found himself uncharacteristically locking horns with some of his good friends. And even John F. Welch Jr., the former General Electric chief executive, was brought in by Clayton Dubilier, where he works as an adviser.

As part of the deal, each buyout firm increased the amount of equity that it will commit to the deal by $150 million each, to $800 million. In a major concession to the banks, Home Depot agreed to finance $1 billion of debt and take up to 12.5 percent of the equity in the supply company.

What has emerged is a tale of bare-knuckled brinksmanship, as the three private equity buyers — Bain, Carlyle and Clayton Dubilier — initially demanded concessions from Home Depot.

In announcing the possible repricing of the sale earlier this month, Home Depot said it would trim the price it was offering in a stock buyback, initially worth about $22.5 billion.

Even so, the buyout firms threatened to walk away from the deal, declaring that the housing market’s decline had created what is known as a material adverse change. Such clauses are common in deals, allowing buyers to walk away. In this case, however, it was not clear whether the declines in the housing and credit markets qualified as deal breakers.

Still, Home Depot buckled and agreed to lower the price to about $9 billion. Then the three investment banks demanded a better deal as well, setting off a marathon of conference calls as the banks threatened to walk away from their financing commitments.

By balking at financing the transaction, Lehman Brothers put itself in an especially difficult position. One of Lehman’s most senior bankers, Andrew Taussig, had advised Home Depot on the sale at the same time that it was also providing financing to the buying group. Suddenly, Lehman was turning around and threatening to scuttle a deal it had advised one of its most important clients to accept.

Mr. Fuld, Lehman’s chief executive, spent hours in person and on the phone with Home Depot’s management and some of its directors trying to explain the firm’s position. Mr. Taussig was mortified, people briefed on the negotiations said.

Because of Lehman’s conflicted position, Goldman Sachs was brought in as Home Depot’s new adviser to mediate among the private equity firms and other banks to reach a deal.

Over the last two years, banks have climbed over each other to lend billions of dollars — and reap lucrative fees along the way — to private equity firms as they have swept up an unprecedented number of companies. To recoup their capital, banks resold the debt as high-yield bonds and loans in the credit markets.

But when the credit markets froze because of the implosion of the subprime mortgage market, investors started refusing to buy nearly all forms of debt not backed by the federal government.

Because of concern about heavy losses in the market for subprime mortgage securities, the stock market has become volatile recently, falling sharply after peaking in mid-July. Credit markets have also been in turmoil. Lenders have cut back on all kinds of loans, not just mortgages but also loans to help finance corporate takeovers by private equity firms.

The financial markets calmed a bit last week after the Federal Reserve stepped in with measures to stimulate lending, but uncertainty over the extent of problems in the credit markets have left many investors unnerved. If the Home Depot deal had fallen apart altogether, that might have been interpreted as a particularly bad sign for the market.

One potential victim of the Home Depot deal is stapled financing, the practice of advising the seller while lending to the buyers. Though the practice has become almost routine in recent years, it is riddled with conflicts and may soon fall out of favor, some bankers have predicted.

Still, by reaching an agreement, Home Depot, the private equity firms and the banks may have saved themselves from a potentially worse fate: years of contentious lawsuits.

The stock prices of companies involved in other pending buyouts are near their deal prices, suggesting that investors expect them to be completed as originally agreed upon. However, when one participant in the Home Depot battle was asked what would happen to the next series of deals, he said: “Study what just happened here. You’ll see this movie again soon.”

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